Your 7-Minute Guide to Making Better Investment Decisions

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Your 7-Minute Guide to Making Better Investment Decisions

 

Investing, in its simplest form, is about finding investment ideas, analysing companies and making decisions.

Your returns can thus be increased by improving any one of the three activities.

In this article I want to give you some ideas on how to improve your decision making. It is something I started a few years ago that has helped me immensely.

It will not only improve your investment returns but, other areas of your life as well.

Give it a try.

 

I have always been an avid reader of anything written by Peter Drucker (1909 – 2005). His ideas on business and management have always been decades ahead of everyone else.

At least once a year I read an article he wrote called Managing Oneself (Click on the link for a PDF copy of the article) which is a small part of his book excellent book Management Challenges for the 21st Century.

In the article Peter describes a technique on how to discover your strengths through the use of feedback analysis.

"Whenever you make a key decision or take a key action, write down what you expect will happen. Nine or 12 months later, compare the actual results with your expectations. I have been practicing this method for 15 to 20 years now, and every time I do it, I am surprised.

The feedback analysis showed me, for instance-and to my great surprise-that I have an intuitive understanding of technical people, whether they are engineers or accountants or market researchers.

It also showed me that I don't really resonate with generalists.

Feedback analysis is by no means new. It was invented sometime in the fourteenth century by an otherwise totally obscure German theologian and picked up quite independently, some 150 years later, by John Calvin and Ignatius of Loyola, each of whom incorporated it into the practice of his followers."

And you can use this technique to evaluate and improve your investment decisions.

Here is how you can do it.

Every time you make an investment write down the answers to the following three questions:

  1. What is my reason for buying?
  2. What is the security worth?
  3. How did I calculate this value?

 

Don't write a long essay just one or two lines.

I have found that, the longer the reason for buying (the more complex the investment case) is the lower my returns usually are.

The simplest investments ideas are usually the most compelling and profitable.

When you review the investment, after a price decline or receipt of new information, look at your reason for buying. If the reason is no longer valid I suggest you seriously consider selling.

Also after selling an investment refer back to your purchase decision and add the return on the investment (in total and per year) as well as your reason for selling.

Every six months or so compare your decisions with the results.

But be careful, a profit does not automatically mean you made a good decision.

A good decision is one where the reasoning behind the decision was correct. Was your thinking process that led you to the buy decision correct?

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For example a profit made through a completely unexpected buy-out of the company would not equal a good decision whereas buying because you thought a security is undervalued and then profiting from a buyout would be a good decision (the undervaluation made the company an attractive buy-out candidate).

I urge you to give it a try, you will be surprised at your findings.

Here is for example what I found:

  • I am a very bad coat-tail investor i.e. buying a security because someone else bought it. I am uncomfortable holding the investment and tend to make bad sell decisions. Either too soon or too late, after a gain has evaporated.

  • Also, if I do too much analysis on an idea I lose my objectivity. I tend to fall in love with the company and tend to see price declines as a reason to keep on buying. Something that has cost me dearly.

That said I am still not 100% sure what my correct amount of research is. But I am sure I am moving in the right direction. Using check-lists as I described in the article What does your checklist look like? was a step in the right direction for me.

I also add securities I have sold to a virtual portfolio as I realised that I often sell investments too soon.

I review this "sold" portfolio six monthly to evaluate the quality of my sell decisions.

I do this for only up to a year after the investment has left my portfolio as thereafter the investment case may have changed and I have stopped following the company.

This has helped my returns a lot as it has, objectively, confirmed my mistake of not letting winners run.

In summary

You make hundreds of decisions every day, some more important than others.

If the quality of your important decision can be improved, even only slightly, it can make a huge difference in your life.

This is of course also true of your investment decisions. 

I urge you to put a system in place to improve your decision making. It will make a big difference in your life, sooner than you expect.

 

Your deciding analyst